Depreciation
- Straight-line
- (cost − salvage)/life
- Double-declining balance
- 2/life × book value at the start of the year
- Sum of the years’ digits
- (cost − salvage) × remaining life/SYD
- SYD
- n(n + 1)/2
- Book value
- cost − accumulated depreciation
Financial Accounting: cram pack
Formula sheets, the key method steps for every topic and 4 practice problems, with full solutions at the back.
1Formulas and methods
2Practice problems
1.Financial accountingMedium
A project costs €100,000 and brings in €25,000 cash per year. What is its payback period?
- A2.5 years
- B4 years
- C25 years
- D5 years
2.Financial accountingHard
A firm has spent €50,000 on market research for a new product and must decide whether to launch it. How should the €50,000 be treated in the decision?
- ASpread over the product's expected life
- BAdded to the launch cost
- CDeducted from expected sales
- DIgnored, because it is a sunk cost
3.DepreciationMedium
A delivery van costs €45 000, has a useful life of 6 years and a salvage value of €7 000. Using the double-declining-balance method (without switching to straight-line), find the depreciation charge D in year 4.
cost = €45 000life = 6salvage = €7 000year = 4
D = €
4.DepreciationHard
A production line costs €120 000, has a useful life of 5 years and a salvage value of €0. Using the sum-of-the-years’-digits method, find the depreciation charge D in year 2.
cost = €120 000life = 5salvage = €0year = 2
D = €
3Solutions
1.Financial accounting
Answer: B · 4 years
Why this is the answer
€100,000 ÷ €25,000 = 4 years. Payback is simple but ignores the time value of money and cash flows after payback.
Answer
B · 4 years
2.Financial accounting
Answer: D · Ignored, because it is a sunk cost
Why this is the answer
The research money is spent whichever choice is made, so it is irrelevant. Only future incremental cash flows from launching should be compared.
Answer
D · Ignored, because it is a sunk cost
3.Depreciation
Answer: D = 4444 €
Depreciation spreads the cost of an asset over its useful life. Straight-line: (cost − salvage value)/life every year. Double-declining balance: 2/life times the book value at the start of each year, so the charge falls each year (salvage is not subtracted, but the book value never goes below it). Sum-of-the-years’-digits: (cost − salvage) × remaining life/(1 + 2 + … + n).
Rate
2/6 = 0.3333
Year by year
year 1: 0.3333·45 000.00 = €15 000.00
year 2: 0.3333·30 000.00 = €10 000.00
year 3: 0.3333·20 000.00 = €6 666.67
year 4: 0.3333·13 333.33 = €4 444.44
Answer
D = €4 444.44
4.Depreciation
Answer: D = 32000 €
Depreciation spreads the cost of an asset over its useful life. Straight-line: (cost − salvage value)/life every year. Double-declining balance: 2/life times the book value at the start of each year, so the charge falls each year (salvage is not subtracted, but the book value never goes below it). Sum-of-the-years’-digits: (cost − salvage) × remaining life/(1 + 2 + … + n).
Fraction for year 2
(5 − 2 + 1)/15 = 4/15
Depreciation
D = 120 000·4/15 = €32 000.00
Answer
D = €32 000.00
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